The Commerce Department said Thursday that consumer spending rose 0.2 per cent last month. That's slightly slower than the 0.4 per cent increase in November.
Income jumped 2.6 per cent in December from November, the biggest gain since December 2004. The main driver of the increase was dividend payments, which companies accelerated to beat the January rise in income tax rates.
Wages and salaries grew 0.6 per cent.
Consumer spending, which accounts for about 70 per cent of economic activity, is expected to slow this year. That's because consumers are receiving less take-home pay starting this month because of an increase in Social Security taxes.
The increase in payroll taxes already hurt consumer confidence this month. And consumers will have less money to spend at a precarious time.
The economy unexpectedly shrank in the October-December quarter at an annual rate of 0.1 per cent, the government said Wednesday. The contraction was largely driven by a steep cut in defence spending. Still, the dip was a reminder of the economy's vulnerability as automatic cuts in government spending loom.
Analysts predict income growth slowed sharply in January because most bonuses and dividends were paid out in December and take-home pay shrank
But Paul Dales, senior U.S. economist at Capital Economics, said the economy would begin growing again in the January-March quarter, in part because modest hiring will keep consumers spending. He predicts consumer spending will grow at a lacklustre 1 per cent rate in the first quarter, down from a 2.2 per cent rise in consumer spending in the October-December quarter.
The big rise in income and slower growth in spending pushed the saving rate in December to 6.5 per cent of after-tax income. That's up from 4.1 per cent in November. It was the highest level for the saving rate since May 2009.
An inflation gauge preferred by the Federal Reserve was flat in December and is up just 1.3 per cent over the past 12 months, well below the Fed's 2 per cent inflation target.
For all of 2012, income rose 3.5 per cent, below the 5.1 per cent rise in 2011 and the weakest since 2009, the final year of the Great Recession.
Congress and the White House reached a deal on Jan. 1 to prevent income taxes from rising on all but the wealthiest Americans. But they allowed the temporary reduction in Social Security taxes to expire this year.
The tax increase will leave a person earning $50,000 a year with about $1,000 less in 2013. A household with two high-paid workers will have up to $4,500 less.
Some analysts have estimated that the roughly $120 billion in higher Social Security taxes could subtract up to 0.7 percentage point from growth this year.
And other policy decisions in Washington could slow growth further.
The agreement on the fiscal cliff averted income tax cuts on most consumers. But it only delayed across-the-board government spending cuts for two months. The cuts are set to take effect on March 1 if no agreement is reached to avert them.
The Fed announced Wednesday that it was keeping all its aggressive stimulus programs in place. These include $85 billion a month in bond purchases. The purchases are intended to keep long-term interest rates down to encourage spending, boost growth and reduce still-high unemployment.
The Fed also left its target for short-term rates at a record low and said it would stay there at least until unemployment, now at 7.8 per cent, stays above 6.5 per cent. Many economists think unemployment remained at 7.8 per cent in January. The January jobs report will be released Friday.